Testing the Validity of Kuznets’ Curve Hypothesis: A Heterogeneous Panel Estimation for the Western Balkans

Abstract

This research aims to test the Kuznets Curve hypothesis about the relationship between economic development and income inequality for the Western Balkan countries by employing a heterogeneous panel data technique. The main objective of this study is to answer the research question as to whether a significant inverse U-shaped relationship is observed between economic development and income inequality in these transition economies. The analysis employs advanced panel estimate methods like Mean Group, Augmented Mean Group and Common Correlated Effects Mean Group, which were calculated using the STATA program. For the regression analysis, the period from 2008 to 2023 is selected and focuses on five countries in the region: Albania, Bosnia & Herzegovina, Montenegro, North Macedonia, and Serbia. The econometric model includes seven independent variables: GDP per capita, trade openness, employment in agriculture, employment in industry, employment in the services, inflation, and domestic credit to the private sector. The findings support the Kuznets Curve hypothesis by demonstrating that GDP per capita exhibits an inverted U-shaped correlation with income inequality. Additionally, while employment in industry, services, and the availability of domestic credit are associated with reduced inequality, work in agriculture and inflation show a positive correlation with inequality. It is interesting to note that trade openness did not consistently lead to the results predicted by theory, and the outputs varied in character depending on the estimator used. iii Given the employment of robust, heterogeneity-sensitive estimation techniques in a transitional regional context with a minimum quantity of empirical research conducted, these results can be a little more informative to the literature and increase the important influence of the policy for the purpose of inclusive economic growth in the Western Balkans.